Answer No 2

In Franchise Your Business, author and franchise consultant Mark Siebert delivers the
ultimate how-to guide to employing one of the greatest growth strategies ever -- franchising.
Siebert shares decades of experience, insights, and practical advice to help grow your
business exponentially through franchising while avoiding the pitfalls. In this edited excerpt,
Siebert digs into the details behind just what makes franchising a growth strategy you might
want to consider. The primary advantages for most companies entering the realm of
franchising are capital, speed of growth, motivated management, and risk reduction -- but
there are many others as well.
1. Capital
The most common barrier to expansion faced by today’s small businesses is lack of access to
capital. Even before the credit-tightening of 2008-2009 and the “new normal” that ensued,
entrepreneurs often found that their growth goals outstripped their ability to fund them.
Franchising, as an alternative form of capital acquisition, offers some advantages. The
primary reason most entrepreneurs turn to franchising is that it allows them to expand without
the risk of debt or the cost of equity. First, since the franchisee provides all the capital
required to open and operate a unit, it allows companies to grow using the resources of
others. By using other people’s money, the franchisor can grow largely unfettered by debt.
Moreover, since the franchisee -- not the franchisor -- signs the lease and commits to various
contracts, franchising allows for expansion with virtually no contingent liability, thus greatly
reducing the risk to the franchisor. This means that as a franchisor, not only do you need far
less capital with which to expand, but your risk is largely limited to the capital you invest in
developing your franchise company -- an amount that is often less than the cost of opening
one additional company-owned location.
2. Motivated Management
Another stumbling block facing many entrepreneurs wanting to expand is finding and
retaining good unit managers. All too often, a business owner spends months looking for and
training a new manager, only to see them leave or, worse yet, get hired away by a competitor.
And hired managers are only employees who may or may not have a genuine commitment to
their jobs, which makes supervising their work from a distance a challenge. But franchising
allows the business owner to overcome these problems by substituting an owner for the
manager. No one is more motivated than someone who is materially invested in the success
of the operation. Your franchisee will be an owner -- often with his life’s savings invested in
the business. And his compensation will come largely in the form of profits. The combination
of these factors will have several positive effects on unit level performance.
Long-term commitment. Since the franchisee is invested, she will find it difficult to walk
away from her business.
Better-quality management. As a long-term “manager,” your franchi¬see will continue to
learn about the business and is more likely to gain institu¬tional knowledge of your business
that will make him a better oper¬ator as he spends years, maybe decades, of his life in the
business.
Improved operational quality. While there are no specific studies that measure this variable,
franchise operators typically take the pride of ownership very seriously. They will keep their
locations cleaner and train their employees better because they own, not just manage, the
business.
Innovation. Because they have a stake in the success of their business, franchisees are always
looking for opportunities to improve their business -- a trait most managers don't share.
Franchisees typically out-manage managers. Franchisees will also keep a sharper eye on the
expense side of the equation -- on labor costs, theft (by both employees and customers) and
any other line item expenses that can be reduced.
Franchisees typically outperform managers. Over the years, both studies and anecdotal
information have confirmed that franchisees will outperform managers when it comes to
revenue generation. Based on our experience, this performance improvement can be
significant -- often in the range of 10 to 30 percent.
3. Speed of Growth
Every entrepreneur I've ever met who's developed something truly innovative has the same
recurring nightmare: that someone else will beat them to the market with their own concept.
And often these fears are based on reality. The problem is that opening a single unit takes
time. For some entrepreneurs, franchising may be the only way to ensure that they capture a
market leadership position before competitors encroach on their space, because the franchisee
performs most of these tasks. Franchising not only allows the franchisor financial leverage,
but also allows it to leverage human resources as well. Franchising allows companies to
compete with much larger businesses so they can saturate markets before these companies
can respond.
4. Staffing Leverage
Franchising allows franchisors to function effectively with a much leaner organization. Since
franchisees will assume many of the responsibilities otherwise shouldered by the corporate
home office, franchisors can leverage these efforts to reduce overall staffing.
5. Ease of Supervision
From a managerial point of view, franchising provides other advantages as well. For one, the
franchisor is not responsible for the day-to-day management of the individual franchise units.
At a micro level, this means that if a shift leader or crew member calls in sick in the middle
of the night, they're calling your franchisee -- not you -- to let them know. And it's the
franchisee’s responsibility to find a replacement or cover their shift. And if they choose to
pay salaries that aren't in line with the marketplace, employ their friends and relatives, or
spend money on unnecessary or frivolous purchases, it won't impact you or your financial
returns. By eliminating these responsibilities, franchising allows you to direct your efforts
toward improving the big picture.
6. Increased Profitability
The staffing leverage and ease of supervision mentioned above allows franchise
organizations to run in a highly profitable manner. Since franchisors can depend on their
franchisees to undertake site selection, lease negotiation, local marketing, hiring, training,
accounting, payroll, and other human resources functions (just to name a few), the
franchisor’s organization is typically much leaner (and often leverages off the organization
that's already in place to support company operations). So the net result is that a franchise
organization can be more profitable.
Unfortunately, it is difficult to quantify or prove this contention. This much we do know:
Research done during the past 10 years shows top quartile franchisors put an average of 40
and 45.6 percent to the bottom line in 2001 and 2002 respectively. How many industries can
you think of where net incomes in this range are even possible?
7. Improved Valuations
The combination of faster growth, increased profitability, and increased organizational
leverage helps account for the fact that franchisors are often valued at a higher multiple than
other businesses. So when it comes time to sell your business, the fact that you're a successful
franchisor that has established a scalable growth model could certainly be an advantage.
When the iFranchise Group compared the valuation of the S&P 500 vs. the franchisors
tracked in Franchise Times magazine in 2012, the average price/earnings ratio of franchise
companies was 26.5, while the average P/E ratio of the S&P 500 was 16.7. This represents a
staggering 59 percent premium to the S&P. Moreover, more than two-thirds of the
franchisors surveyed beat the S&P ratio.
8. Penetration of Secondary and Tertiary Markets
The ability of franchisees to improve unit-level financial performance has some weighty
implications. A typical franchisee will not only be able to generate higher revenues than a
manager in a similar location but will also keep a closer eye on expenses. Moreover, since the
franchisee will likely have a different cost structure than you do as a franchisor (she may pay
lower salaries, may not provide the same benefits packages, etc.), she can often operate a unit
more profitably even after accounting for the royalties she must pay you.As a franchisor, this
can give you the flexibility to consider markets in which corporate returns might be marginal.
Of course, you never want to consider a market you don't feel provides the franchisee with a
strong likelihood of success. But if your strategy involves developing corporate units in
addition to franchising, you'll likely find your limited capital development budget won't allow
you to open as many locations as you'd like. Franchisees, on the other hand, could open and
operate successfully in markets that are not high on your priority list for development.
9. Reduced Risk
By its very nature, franchising also reduces risk for the franchisor. Unless you choose to
structure it differently (and few do), the franchisee has all the responsibility for the
investment in the franchise operation, paying for any build-out, purchasing any inventory,
hiring any employees, and taking responsibility for any working capital needed to establish
the business.The franchisee is also the one who executes leases for equipment, autos, and the
physical location, and has the liability for what happens within the unit itself, so you're
largely out from under any liability for employee litigation (e.g., sexual harassment, age
discrimination, , consumer litigation (the hot coffee spilled in your customer’s lap), or
accidents that occur in your franchise (slip-and-fall, employer’s comp, etc.).Moreover, it's
very likely that your attorney and other advisors will suggest you create a new legal entity to
act as the franchisor. This will further limit your exposure. And since the cost of becoming a
franchisor is often less than the cost of opening one more location (or entering one more
market), your startup risk is greatly reduced.The combination of these factors provides you
with substantially reduced risk. Franchisors can grow to hundreds or even thousands of units
with limited investment and without spending any of their own capital on unit expansion.